Stock Market are volatile post pandemic, first a big fall in 2020 then sharp rise in 2021 and again a fall in 2022 which lasted till first few months of 2023. Markets saw covid, decade high inflation, an ongoing war, fastest interest rate hikes by central banks in history, trade war between China-US, recession in many economies and what not. Many markets fell as much as 50% from highs but surprisingly reversed from April of 2023. e.g. tech heavy Nasdaq is up more than 40% from March-23 lows. Rally was mainly in anticipation that central banks will pause the rate hike and eventually cut the rates from end of the year.
Most central banks are depending on data to decide the future course of action and the data is what worrying the experts and there is a talk of big fall in stock markets. There is too much diversity in data, for example US economy is red hot despite such high interest rates and that is actually surprising, labor market is strong, GDP is growing at a fast pace, housing market is good(though not in very great shape) and most importantly inflation is still far away from the from fed anticipated(2-6%) range.
On the other hand, situation is totally different in Europe, war is still on as a result food prices are high, supply chain troubles are lingering as a result inflation is still very high compared to other part of the world. Asia the consumption power house of world is in different situation. On the one hand Indian economy is booming(projected to remain one of the fastest growing in world) with moderate inflation and Japan’s economy is growing after decades of sluggish growth. Middle east is in good shape but trouble is in China.
China, world’s second largest economy by GDP is struggling and worrisome part is no one exactly knows how deep the problems are. First their tech company became prey to hostile government policies, their economy crumbled dud to zero covid policy, trade war with US and fear of government controlling data of users through their tech companies further esclated the tension. Now their real state and housing sector is in deep trouble, one of their largest real state behemoth ‘Evergrande’ recently applied for US bankruptcy protection.
Unemployment rate in China is too high that authorities have stopped publishing the data of certain age group in public, last reported it was around 21% but some unofficial report suggests it is as high as 50%, where on one hand world is fighting inflation China on the other struggling with deflation, demand in China is on decadal low. Chinese government is trying hard to push the economy out of danger by providing cushioning but it won’t seem working.
Trouble is, to tackle such deep deflation either a large stimulus is needed or drastic measures from Chinese central bank is needed, which is to cut the policy rates significantly but China is not willing to do so as it don’t want to depreciate its currency too much against USD, already Chinese yuan is on decadal low against USD.
The stock market dilemma
Markets are always divided between bulls and bears causing the price action, but now seems more divided, on the one side there are bulls who see no major correction around and on another there are bears who are preparing for a big fall. Bulls are of view that there’s nothing wrong in US economy, Europe is recovering from inflation and supply chain shock, India is firing on all cylinders, Japan is doing good and supply side worries are easing so why should bulls worry?
But bears are of view that rally in US stock market is propelled by some big fancy names like Nvidia, there’s no broader participation from core sectors, in bears view it is ironical that in current stock market rally tech heavy Nasdaq was in forefront and when yields are this high usually people ditch leveraged tech names, this time it will be no different and this tech led rally is just a blip in time. Bears are counting on China trouble and the view is, market is underestimating China trouble and world’s 2nd largest economy struggling will drag the world with it.
There is one more reason behind bears such high confidence, greatest investor of all time ‘the wizard of Omaha’ Warren Buffet has sold stocks worth more than $8 billion in past few weeks and Michael Burry ‘the man who predicted 2008 financial crisis’ is taking the biggest bet of his life, he has shorted the US market with putting $1.6 billion out of his kitty. Lets do what we can do the best, looking at the historical data and try to predict the outcome.
Is things really that bad in China?
China back in 2015, during capital outflow scare provided boost to infrastructure investment and came out of trouble by encouraging property market speculation, among other measures. That infra boost was primarily fueled by ‘debt’ and that is the root cause of recent events. China’s covid policy was stricter than many other countries of world, Chinese people opposed these policies and when these policies were reversed by the Govt overnight, hope was spending boom will come in China like other parts of the world, though started but that ‘revenge spending’ spree never happened in China.
Household spending is below pre-covid levels despite low base so the obvious question, will China be able to grow its GDP at 5% as target set by country for this fiscal. Experts are skeptical, In order to grow at this pace it need to convince its household to save less, spend more. But here is the catch, household consumption, as a percentage of gross domestic product (GDP), was among the lowest in the world even before COVID, so post covid it is worse. It is a structural issue in an economy relying too heavily on debt-fueled investment.
The problem is people there have a good chunk of investment in real state as it was fastest growing sector few years back but the way prices are falling and there is no sign of stability people are not ready to spend or invest more. Though official reports suggest that China property prices fell only 2-6% but unofficial sources(on ground reports from brokers) suggest prices are down by more than 20-25% in many areas. Real state isn’t only worry for China, due to excess govt intervention, harsh lockdown, trade war with US and one sided policies on supply chain issues, many country which were manufacturing their product in China are moving out.
China once ‘manufacturing hub’ of world is loosing this tag, China(+1) plus one is getting popular with every moving day, countries wants to diversify their supply sources and manufacturing apart from China and this sudden migration is causing heavy job loss in China, reports suggest unemployment rate in China is at 21%, some even claim that it is as high as 51%. With such high unemployment rate, crumbling housing sector(a major investment of households) it is becoming tough for them to save less, spend more.
Is Chinese economy in a prolonged ‘stagflation’ like situation?
Some experts suggest China have limited number of options to work with. To avoid stagflation like situation a major boost is needed in terms of large tax rate cuts, government-funded consumer vouchers, encouraging faster wage growth, building a social safety net with higher pensions, unemployment benefits and better and more widely available public services to boost consumer confidence, but China is sitting on a mountain of debt specially at local govt level thus making it difficult for any type of stimulus they provide to actually work.
Stimulus will further increase the already high debt. In the past, Beijing has lit a fire under its economy through investment, often debt-driven, in infrastructure and manufacturing, but that couldn’t go on forever. There is an absorption limit on everything be it infra or manufacturing and that limit seems to be reached for China as it’s Infra projects are not getting absorbed. It is reflected in defaults that Chinese real state companies are doing. “Evergrande” filed for bankruptcy protection and health of another major reality real state giant ‘Country Garden’ is suspicious as it is defaulting on its recent debt payment.
From $500 billion in 1992 to $18 trillion in Chinese economy 2022, the dream run of Chinese economy is about to come to a halt if not appropriately handed.
The local government debt trouble
Very high local government debt is a major concern for Chinese government, major drop in land sales revenue and cost of imposing harsh covid lockdowns are the primary reason behind mounting local govt debt. The severe fiscal stress seen at local levels not only poses great risks to Chinese banks, but also squeezes the government’s ability to spur growth and expand public services. Though China has introduced few measures to boost the growth and contain the spread but they don’t see doing much to rescue.
Anticipation is the economy may not recover in the second half and growth would fall far short of 5% this year if the property sector does not stabilize, either because property policy is not eased significantly, or proven insufficient to halt the fall. In which case, a prolonged deep property downturn will continue to depress income and confidence of both the corporate and household sectors, as well as prices.
However one thing is sure, Even if major fiscal support is offered, the long-term property fundamentals have changed — China’s population has likely peaked, urbanization is slowing and home ownership is already very high. This means that property demand and construction will remain significantly below the 2020-2021 peak levels even after they rebound from the current lows.
Can China export its deflation to world and a contra view – why it can be a blessing in disguise?
The possibility of it happening is very high as in this inter-related world a lot of products are still coming from China, specially in US. Despite trade tensions and China trying to diversify from its traditional real state and debt led manufacturing activities to consumption led economy China is still manufacturing too much for the world. A research shows that the post covid, when restrictions were lifted demand was not as much as expected and due to export restrictions a lot of Chinese supplies were moving into domestic market. But less demand and high supply crumbled the prices and brought a phase of deflation that is still going on.
Why a blessing in disguise for economy?
Central banks around the world are fighting the inflation, an inflation primary driven by supply chain issues, raw material prices, energy prices and commodity prices. China is a big supplier/user of many of these commodities and deflation hitting China will reduce prices all around. As a result, Chinese economic weakness and falling prices (especially Chinese producer prices) are likely to spill over into global markets — near-term good news specially for the Western central banks’ fight against elevated inflation.
“According to U.S. Census Bureau data as of June, prices of goods imported from China are down 3% on average versus last year, while producer prices of consumer goods in China are down 5% in dollar terms, so spillover will happen in many part of the world including Europe. In fact, these declines are being passed on to U.S. consumers; July marked the first time since the early days of the pandemic that U.S. consumer retail goods prices declined on a three-month annualized basis.”
Boil in crude price and can it sustain?
If worlds second largest economy and one of the largest importer of crude oil is struggling then how can crude oil price be on multi month high. For the context, Oil prices are on track to reach $100 a barrel this month for the first time in 2023 after surging by almost 30% since June, after Russian and Saudi Arabian production cuts. One of the major oil cartel OPEC+ has decided to keep slashing the supply.
Brent crude, the oil price benchmark, rose to a 10-month high last week of almost $94 a barrel, up from $72 a barrel at its lowest point in June – heading for its biggest quarterly increase since Russia’s invasion of Ukraine. The lighter US crude, West Texas Intermediate, has climbed from $67 a barrel to $90 a barrel over the same period. Both benchmarks were up by about 4% on the week.
The supply issue
Earlier this month, Saudi Arabia extended 1.3m barrels per day (bpd) of combined cuts to the end of the year, accelerating a drawdown in global inventories. Supply cuts by Russia to boost prices have also supported efforts by other countries to push prices towards $100 a barrel. The International Energy Agency (IEA) warned last week that the ongoing supply cuts made by these two Opec+ leaders would create a “significant supply shortfall”, which poses a considerable threat to ongoing price volatility.
The report was released just a day after Opec announced that the market was facing a deficit of more than 3m bpd in the upcoming quarter, potentially resulting in the most substantial supply shortage in more than a decade. Oil prices are also rising in the hope that Chinese authorities are trying hard to increase the buoyancy in economy by taking a number of measures to control the spillover effect of deflation.
Recent data from China added fuel to the hope as Retail sales grew by 4.6% in August from a year ago, beating expectations for 3% growth forecast by a Reuters poll. The increase was also faster than the 2.5% year-on-year pace in July. Industrial production grew by 4.5% in August from a year ago, better than the 3.9% forecast and faster than the 3.7% increase reported for July.
But real state and housing sector is still dragging the fixed asset investment that grew by 3.2% against expectations of 3.3%. The figure was dragged down by a steeper drop in real estate investment, and a slowdown in infrastructure investment. Only manufacturing saw the pace of investment pick up. Among the fixed asset investment private, non-state investment fell by 0.7% in the first eight months of the year from a year ago — worse than the 0.5% decline in the first seven months of the year.
It is too early, in fact immature to get excited about China economy establishing as the problem in real state/urban housing is still not improving. I personally don’t see crude price sustaining above $90-95 in long run. Most central banks are in a comfortable position because inflation is falling but if oil/energy prices are rising again then central banks will resume their tough stance by hiking rates more. Imagine rates going up from here, it not only bring back recession fears but also will crumble demand for commodities for long term.
As central banks are depending on data, either they will keep getting favorable results in fight against inflation or they will keep their fight on, in any case high energy price is not an option and my strong belief is cutting supply to manage demand isn’t going to work as some producer will defy it supplying extra output in market.
What about Stock Market, Will they watch economy more?
Stock market and economy are not moving vis-a-vis from quite some time and that polarization is major cause of worry for economists, most surprising is rally in tech names as tech heavy NASDAQ rose more than 50% from early 2023 lows when interest rates are on decadal high, usually in such uncertain environment people prefer safe assets/stocks to hide on. This is the main reason for some betting on big correction in 2023. Though a possibility of 2023 recession is very low or close to nil but experts are still seeing recession looming in 2024. Moody’s recession predictions methodology
This can be the reason for big names becoming cautious on stock market as they see economy facing challenges going ahead. Market wizard and oracle of Omaha Warren Buffet recently sold stocks worth more than $8 billion and that cause a panic among investors while it can just be a case of keeping cash and investing it in risk-free short term treasury as currently they are fetching inflation beating return.
But, some believe It’s possible Buffett is shoring up his cash reserves to buy stock when that happens. The three factors Buffett views as risks to the U.S. economy — the U.S. banking sector, China, and the over-valued commercial real estate market — still exist. Whether the U.S. can really have a soft landing from inflation and leave not just 2023, but 2024 unscathed, remains to be seen. Investors will be watching Buffett’s next moves carefully to see if the Oracle of Omaha’s lack of confidence in the stock market continues.
Fitch ratings view on US economy
Conclusion
While remaining invested one should look to minimize risk by investing in safe stocks, staying away from overheated sectors/stocks and keeping some cash in case opportunities come knocking. In my view predicting the steep fall or rise is a challenging and cumbersome task, instead one should spent time studying/researching the themes and stocks that can provide sustainable return going forward.
“One thing is certain, the FOMO and TINA factor will always come to rescue in any sizeable correction so keep actively looking for opportunities patiently is the best option to surviving in market.”
